Explain the difference between provision, contingent

liability and contingent asset per IAS 37 Provisions, Contingent Liabilities and
Contingent Assets
- IAS 37 Provisions, Contingent Liabilities and Contingent Assets outlines the
accounting for provisions (liabilities of uncertain timing or amount),
together with contingent assets (possible assets) and contingent liabilities
(possible obligations and present obligations that are not probable or not
reliably measurable). Provisions are measured at the best estimate
(including risks and uncertainties) of the expenditure required to settle
the present obligation, and reflects the present value of expenditures
required to settle the obligation where the time value of money is
material.

Discuss recognition criteria for provision, contingent

liability and contingent asset and their treatment in
the financial statements per IAS 37.
- An entity must recognise a provision if, and only if:
- a present obligation (legal or constructive) has arisen as a result of a past
event (the obligating event), payment is probable ('more likely than not'),
and the amount can be estimated reliably.

Critically discuss adjusting and non-adjusting events and their treatment in the
financial statements per IAS 10 -Events after the Reporting Period.
- IAS 10 Events After The Reporting Period contains requirements for when
events after the end of the reporting period should be adjusted in the
financial statements. Adjusting events are those providing evidence of
conditions existing at the end of the reporting period, whereas non-
adjusting events are indicative of conditions arising after the reporting
period (the latter being disclosed where material).

Question 1

All the events described in each example occur before the financial statements
are authorised for issue to the shareholders, and so all fall in the period covered
by events after the reporting period.
 1. The event should be classified as an adjusting event occurring after the
end of the reporting period. Further information is now available that
throws more light on the prevailing position of the receivables balance at
the year end. The adjustment should be to write off the debt as an
expense.
2. This is an adjusting event as it related to a condition which existed at the
statement of financial position date (the faulty inventory). The figure for
closing inventory should be reduced from £80,000 to £60,000, which will
reduce current assets on the statement of financial position and profits.
3. This is an adjusting event. The receipt of the insurance claim provides
additional or further evidence of conditions (negotiation of insurance
claims) that existed at the statement of financial position date. A
receivable for £200,000 will be shown in the statement of financial
position and also credited to the income statement.
4. A catastrophic event such as a fire occurring after the statement of
financial position date is included in the examples given in IAS 10 Events
after the Reporting Period as a non-adjusting event, even though it may
affect the value to the business of its assets. At the statement of financial
position date the condition of the inventory was unaffected and would
have been valued at the lower of cost and net realisable value; this latter
figure has to be estimated as at the statement of financial position date.
The chairs therefore remain valued at their cost of £45,000 in the financial
statements. If the effect of the fire is considered material, a disclosure
note will be made, giving details of the fire and an estimate of its financial
implications.
5. The lost warranties and repair contract do not affect the initial cost of
the new machine recognised. However the company needs to consider
whether the lack of maintenance cover indicates that the asset was
impaired at the statement of financial position date. The value-in-use may
change if the company determines that it will use the differently. In this
case this would be accounted for as an adjusting event occurring after the
end of the reporting period.

Question 2

Provisions have to be created when it is probable that the organisation will have
to transfer economic benefits. The probability is taken as more than 50% likely.
(a) Present obligation as a result of a past obligating event:
The obligating event is the employment contract in which the company is liable
to provide health and safety for its employee.
Outflow of resources embodying economic benefits:
Probable.
Conclusion:
The directors need to create a provision for £20,000 as the employees’ claim is
probably going to succeed.

(b) Present obligation as a result of a past obligating event:

The obligating event is the provision of a hair-cut service to the customer.
Outflow of resources embodying economic benefits:
Not probable (customers claim unlikely to succeed).
Conclusion:
No provision to be made for the customer’s claim.

Question 3

Legal action against Xanver plc

Present obligation as a result of a past obligating event:

Some event must have occurred before the end of the financial year, for the
claim to have been made in February 20X7.
Outflow of resources embodying economic benefits:
Probable that the liability will materialise.

Conclusion

Xanver should make a provision for £200,000 (if this is the best estimate of the
probable outflow).

Legal action taken by Xanver plc

Present obligation as a result of a past obligating event:

Some event must have occurred before the end of the financial year, for Xanver
to have made a claim in March 20X7.
Inflow of resources embodying economic benefits:
Xanver has been advised that it is probable that it will win the case, therefore a
probable asset.

Confirmation of possible asset:

This is dependent on the success of the lawsuit by Xanver (uncertain future

event, not wholly within the control of the company).
Conclusion:
Xanver should disclose a contingent asset as a note for the legal action it has
taken.

Note the difference in treatment of the two probably likely cases. The legal
action against X plc (probable outflow of resources) results in the recording of a
provision; yet the legal action by X plc (probable inflow of resources) results in
a disclosure note only.

Question 4

Question 4

(a) Present obligation as a result of a past obligating event:

There is no obligation for the costs of fitting smoke filters because no obligating
event has occurred (the fitting of the filters). However, an obligation might arise
to pay fines or penalties under the legislation because the obligating event has
occurred (the non- compliant operation of the factory).
Outflow of resources embodying economic benefits in settlement:
Assessment of probability of incurring fines and penalties by non-compliant
operation depends on the details of the legislation and the stringency of the
enforcement regime.
Conclusion:
No provision is recognised for the costs of fitting smoke filters. However, a
provision is recognised for the best estimate of any fines and penalties that are
more likely than not to be imposed.

(b) Present obligation as a result of a past obligating event:

This is a constructive obligation as Abel plc has made refunds from previous sales
to customers for many years, so a valid expectation has been created that it will
continue to do so. The sales are the obligating event.
Outflow of resources embodying economic benefits:
Probable as Abel plc has made the refunds for many years.
Conclusion:
A provision should be created by Abel plc at the end of its reporting period, 31
October 20X5.

(c) Present obligation as a result of a past obligating event:

There has been no obligating event and so there is no obligation. Conclusion:
No provision is required.

If by 20 October 20X5 a detailed plan for closing down the division was agreed
by the board, letters were sent to customers warning them to seek an
alternative source of supply and redundancy notices were sent to the staff of
the division, then the decision would change:

Present obligation as a result of a past obligating event:

The obligating event is the communication of the decision to the customers and
employees, which gives rise to a constructive obligation from that date, because
it creates a valid expectation that the division will be closed.
Outflow of resources embodying economic benefits:

Probable

Conclusion:

A provision is recognised at 31 October 20X5 for the best estimate of the costs
of closing the division.

Question 5

Present obligation as a result of a past obligating event:

There is no present obligation.

Conclusion:

No provision is recognised.

The costs of overhauling aircraft are not recognised as a provision. Even a legal
requirement to overhaul does not make the costs of overhaul a liability, because
no obligation exists to overhaul the aircraft independently of the airline
company’s future actions – the company could avoid the future expenditure by
its future actions, for example by selling the aircraft. Instead of a provision being
recognised, the depreciation of the aircraft takes account of the future incidence
of maintenance costs.

Question 6

1. This is an event after the reporting period and is an adjusting event. The
conditions relating to the payment of the bonus existed at the statement
of financial position date; the adjustments to the profits are providing
evidence of how much the bonuses should be. The bonuses will be
reduced to £4,500 each in the financial statements at 31 March 20X1.
2. The decision to discontinue the division is an event after the financial
reporting period. It does not affect any conditions that existed at the
statement of financial position date and is therefore a non-adjusting
event. However, because the division is considered to be material to the
financial statements Carstairs plc would need to make disclosure within
the 31 March 20X3 financial statements concerning the closure of the
domestic appliances division.

Question 7

31 March 20X6

Minor repairs £3 million 14% £420,000

Major repairs £12 million 1% £120,000

Total: Warranty Provision £540,000

Dr. Expense (F/S)

Cr. Provision (SFP) liability

31 March 20x7

Minor repairs £3.5 million 14% £490,000

Major repairs £13 million 1% £130,000

Total: Warranty Provision £620,000

Dr. Expense (F/S)

Cr. Provision (SFP) liability

No repairs: 85% of the product

Minor repairs: 14%

Major repairs: 1%

31 March 20X7  actual cost of repairs £480,000

Opening provision 1 Apr 20X6 £540,000

Actual costs charged £480,000

£60,000

Change to income statement £560,000 (1)

Closing provision 31 March 20X7 £620,000 (2)

(1) 620,000 – 60,000 = 560,000

Dr. Provision 540,000
Cr. Gain (I/S) 60,000
Cr. Cash 480,000

(2) SFP  Current liabilities: Provision £620,000

I/S  Expense £620,00 – Gain (£60,000) = Net expense £560,000

Question 8
a) Court case: the obligating event is he supply of beer in October 20X3, and
there is a present obligation as an offer of £10,000 has been made. A
provision should therefore be made. However, the offer has not yet been
accepted, and it is uncertain whether it will be accepted or whether the
customer will pursue the case. At 31 December 20x3 the best estimate for
the provision is £10,000. The company may decide to disclose brief details
about the uncertainty over this amount since the outcome of this
increasing cannot be considered remote.
b) Hops: straightforward liability. An obligation arises from a past event and
there is no uncertainty. The purchase and the liability should be included
in Warwick Refreshements’ financial statements at 31 December 20X3.
c) Guarantee: no present obligation exists as Bottlebank has both net assets
and met the terms of the loan. There is a possibility that the guarantee
 will be called in during the next 5 years and therefore the granting of the
guarantee (the obligating event) may give rise to a possible obligation.
This is a contingent liability which should be disclosed in the notes to the
financial statements.
d) Environmental discharge: the damage occurred as a result of an obligating
event – the discharge of beer. The fine of £20,000 and rectification costs
of £200,000 will already be included in the accounts. There is an obligation
to make good further environmental damage. There is uncertainty
concerning the amount. If it is considered more likely than not that
Warwick Refreshments will have to pay more in damages, a provision
should be made and a best estimate of the amount will be required. The
company may take the mid-point of £120,000 as this figure. Otherwise
the possibility of further damages will be treated as a contingent liability
and a disclosure note included in the financial statements, which explains
the possible outflow and provides a range of possible amounts.